Citation Codes

Equivalent Citations

citation codes

Case Number

Income-tax Reference No. 777 of 1974

Judges

Satish Chandra, C.J
K.N Goyal, J.

Acts

section 36(1)(vii) of the Income-tax Act, 1961.

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Smart Summary

Judicial Opinion Summary (Satish Chandra, C.J.)

Factual and Procedural Background

The assessee is a registered firm engaged in business including petroleum products, automobile repairs and fabrication. The assessment year in question is 1961-62, the relevant accounting period being the calendar year 1960. Two questions were referred for the court's opinion.

First factual strand (bad-debt issue): From 1951 the assessee carried out fabrication work for Free India Dry Accumulators Ltd. (“Fida”). By early 1958 Rs. 7,721 was due directly from Fida. Two related companies under the same management—M/s Shankar Distillery (Rs. 14,711 due) and M/s Shankar Sugar Mills (Rs. 45,000 due)—had amounts transferred with the assessee’s consent into Fida’s account on 1 January 1958. In 1959 Fida was purchased by Sri Krishna Chowkhany; the new management negotiated with creditors and agreed to settle debts by payment of 10%. The assessee’s total debt due from Fida was Rs. 66,964; it received 10% and wrote off the balance of Rs. 60,268 during calendar year 1960. The assessee claimed the full Rs. 60,268 as an allowable deduction; the ITO disallowed the claim; the AAC allowed Rs. 57,122; the ITO appealed to the Tribunal, and the matter reached the court.

Second factual strand (rental income issue): A plot at 113, Park Street, Calcutta, was the subject of civil litigation and a receiver (M/s Talbot & Co.) was appointed. The receiver had leased the plot including a motor-repair workshop to the assessee in 1940 for 10 years at Rs. 700/month; the assessee installed machinery and sub-let to M/s Poddar Automobiles Ltd. at Rs. 2,500/month. The receiver obtained a decree on 1 December 1949 terminating the lease and awarding mesne profits from 28 February 1947. A suit by heirs of a partner against the receiver (filed in 1950) was ultimately compromised on 25 July 1959: Talbot & Co. agreed to pay Rs. 64,680 as accumulated rent for 1950–58 subject to deductions (income-tax Rs. 13,329 and receiver’s commission Rs. 3,234) and Rs. 4,372 interest on government securities; the net amount received by the assessee was Rs. 52,489. The assessee recorded legal expenses of Rs. 8,492 and credited Rs. 43,997 to partners’ capital accounts.

Procedurally, the ITO treated the amount as taxable in the year of receipt (17 November 1960) on the basis that the assessee had adopted a cash system of accounting; the AAC affirmed; the Tribunal deleted the inclusion of Rs. 43,997. The court reviewed both referred questions and delivered its opinion.

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that the sum of Rs. 57,122 was a bad debt allowable under section 36(1)(vii) of the Income-tax Act, 1961.
Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in deleting the amount of Rs. 43,997, being the rental income received during the previous year relevant to the assessment year 1961-62.

Arguments of the Parties

Assessee's Position

Claimed the written-off debt (total Rs. 60,268) as an allowable deduction under s.36(1)(vii), on the basis that the debts were trading/business debts and became bad in the relevant accounting period when the new management of Fida settled creditors at 10%.
Contended that rental receipts arising from the 1959 compromise (net Rs. 43,997 credited to capital) were not taxable in the accounting period 1960 because the assessee followed the mercantile system; the right to receive accrued on compromise in July 1959 and thus, if assessable, it would be assessable for the year relevant to the accounting year 1959 or earlier accounting years where assessments were open.
Maintained that non-recognition of accruals in earlier years was justified because of pending civil litigation which made it uncertain whether the income would be received.

Revenue / ITO's Position

Disallowed the bad-debt claim in entirety at initial assessment level.
For the rental amount, the ITO treated the receipt of Rs. 52,489 on 17 November 1960 as taxable in assessment year 1960-61 under "Other sources", reasoning the assessee had adopted the cash system for this source and hence the amount was assessable in the year of receipt.
The ITO had earlier accepted parts of the income in revised returns for certain earlier years (1956-57 and 1957-58) but contended for inclusion in 1960-61 for the balance that escaped earlier assessment.

Table of Precedents Cited

No precedents were cited in the provided opinion.

Court's Reasoning and Analysis

The court reviewed the Tribunal's factual findings and legal inferences and accepted them for both referred questions. The court’s analysis proceeded as follows:

Bad-debt question (Rs. 57,122)

The Tribunal found that the Rs. 7,721 directly due from Fida was an ordinary trading/business debt arising from work done in the course of business; until the change of management the debtor had not repudiated the debt and there was no reason to regard it as bad prior to that event.
The new management's indication that it would pay only 10% constituted the event in the relevant accounting period (calendar year 1960) when the debt effectively became irrecoverable, i.e., bad.
Regarding the amounts originally due from the two sister concerns (Rs. 14,711 and Rs. 45,000), the Tribunal found on the record that their transfer to Fida’s account was by book adjustment with the assessee’s consent and without cash payment; this transfer did not change the true nature of those obligations, which remained trading debts arising from fabrication work done for those concerns.
The agreement with Fida (to accept 10% in full settlement) was found genuine on the materials; consequently 90% of those debts became bad in the year in question and were allowable under section 36(1)(vii).
The court accepted these factual findings as based on ample material and concluded that a sum of Rs. 57,122 became a bad debt in the year in question and was allowable as a deduction.

Rental-income question (Rs. 43,997)

The Tribunal noted the assessee had sold away the rights in the land and the machinery installed thereon in 1958; accordingly the source of rental income ceased to exist before the accounting period relevant to assessment year 1961-62 (calendar year 1960).
The Tribunal and the court accepted that the assessee had been following the mercantile system of accounting. Given the pendency of civil litigation, the assessee was justified in not recording accruals for rent for the years 1950–58 because it could not be certain of receiving income from the property while disputes continued.
The right to the compromise amount accrued in July 1959 (date of compromise). Applying the assessee’s normal (mercantile) accounting method, the portion of the compromise attributable to accrued rent could, if assessable, be held assessable for the year relevant to the accounting year 1959 rather than for the accounting year 1960.
The court observed an inconsistency in the ITO’s approach: the ITO had accepted revised returns and assessed portions of this income for 1956-57 and 1957-58 (on an accrual basis), and therefore could not validly take a contrary position and tax the remainder as income of 1960-61 on a supposed cash-accounting basis.
On these bases the Tribunal’s deletion of the inclusion of Rs. 43,997 from the assessee’s income for the year 1960 was sustained by the court.

Holding and Implications

Holding: Both questions referred were answered in the affirmative in favour of the assessee and against the Revenue.

Direct consequences of the holding:

The Tribunal’s conclusion that Rs. 57,122 constituted a bad debt allowable under section 36(1)(vii) for the accounting year in question is affirmed; the assessee is therefore entitled to the deduction so found allowable by the Tribunal.
The Tribunal’s deletion of the inclusion of Rs. 43,997 (net rental amount credited to partners) from the assessee’s income for the accounting year 1960 is affirmed; the amount is not taxable in assessment year 1961-62 on the facts and accounting treatment shown.
The assessee is awarded costs of Rs. 200.

Implications regarding legal precedent: The opinion resolves the referred factual and legal questions between the parties on the record. The text does not indicate the creation of a new, general precedent beyond the application of the facts to the statutory provision cited (section 36(1)(vii)) and accepted accounting principles (mercantile versus cash basis) as applied in this case.

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Addl. Commissioner Of Income-Tax v. Ganesh Das

Satish Chandra, C.J:— The assessee is a registered firm. It carries on business in petroleum products, automobile repairs and fabrication, etc. The assessment year in question is 1961-62, for which the relevant accounting period was calendar year 1960.

2. Two questions have been referred for our opinion. One is whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that the sum of Rs. 57,122 was a bad debt allowable under section 36(1)(vii) of the Income-tax Act, 1961. The relevant and material facts in respect of this question are that the assessee had been doing fabrication work for a concern called, Free India Dry Accumulators Ltd. (“Fida” for short) since 1951. By the beginning of 1958 a sum of Rs. 7,721 had become due to the assessee from Fida. Fida had two subsidiary concerns, called M/s; Shanker Sugar Mills, Captainganj, and Shankar Distillery. These were also under the same management as that of Fida. The assessee-company did some fabrication work for these two concerns also. On 1st January, 1958, Rs. 14,711 were due from M/s. Shankar Distillery and Rs. 45,000 from M/s. Shankar Sugar Mills. With the consent of the assessee, these sums which were due from the two subsidiaries were transferred to the account of Fida.

3. In 1959, Fida was bought over by one, Sri Krishna Chowkhany. The solicitors of the new management contacted the various creditors of Fida, and ultimately it was agreed that the entire debts would be cleared on payment of 10 per cent, thereof. The assessee-company, whose total debts amounted to Rs. 66,964 as against Fida, received 10 per cent, thereof and wrote off the balance, namely, Rs. 60,268, during the calendar year 1960.

4. The assessee claimed the entire amount of Rs. 60,268 as an allowable deduction.

5. The ITO disallowed the claim in its entirety.

6. On appeal, the AAC allowed relief to the extent of Rs. 57,122. The assessee felt satisfied, but the ITO went up in appeal to the Tribunal.

7. The Tribunal held that in so far as the amount of Rs. 7,721 which was due directly from Fida was concerned, it was undoubtedly a business debt. It was an amount due for work done by the assessee in the course of its business. Throughout the period from 1951 to 1958, the debtor had not repudiated the debt, and, therefore, there was no reason for the assessee to think that it had become a bad debt. It became a bad debt when the management of Fida changed and the new management indicated that it was not prepared to pay anything more than 10 per cent. This event happened during the relevant accounting period for the assessment year 1961-62. The claim so far as Rs. 7,721 was concerned was hence allowable. In respect of the other two items, namely, Rs. 14,711 due from M/s. Shankar Distillery, and Rs. 45,000 due from M/s. Shanker Sugar Mills, the Tribunal found on facts that there was no material on the record to assume that the transfer of these two amounts to the account of Fida was either in cash or made as a deposit. On the materials it was evident that the assessee agreed to the transfer because the new management of Fida insisted upon it and with a view to realise as much of this debt as was under the circumstances possible. It was transfer of a trading debt from one concern to another sister concern, and the true nature and character of the debt did not change by this transfer. The transfer was made by adjustment in books and no amount was paid in cash. Since the original amount was due for the fabrication work done for these two concerns, they represented trading debts. Their nature did not alter by reason of the transfer to Fida. The agreement with Fida to write off the balance on payment of 10 per cent, of the debt was genuine. Consequently, the 90 per cent, amount of these two debts became bad in the year in question and were allowable as a deduction under s. 36(1)(vii) of the Act.

8. We have heard learned counsel and are satisfied that on these facts, which are based on ample material on the record, the Tribunal was justified in coming to the conclusion that a sum of Rs. 57,122 became a bad debt in the year in question and was allowable as a deduction. The first question is, therefore, liable to be answered in favour of the assessee.

9. The second question referred for our opinion is whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in deleting the amount of Rs. 43,997, being the rental income received during the previous year relevant to the assessment year 1961-62.

10. The relevant facts in respect of this question are that a plot of land at 113, Park Street, Calcutta, became the subject-matter of dispute in a civil court. The court appointed M/s. Talbot & Co. as receiver. The receiver leased out the plot of land, including the ‘motor repair workshop standing on it, to the assessee in the year 1940 for a period of 10 years at Rs. 700 per month plus taxes. The assessee fixed the requisite machinery for motor car repairs and sub-leased the property and the machinery to M/s. Poddar Automobiles Ltd. on a monthly rent of Rs. 2,500.

11. The receiver filed a suit for ejectment and obtained a decree on 1st December, 1949, entitling the receiver to terminate the lease and to recover mesne profits at the rate of Rs. 60 per day from 28th February, 1947, till possession.

12. The heirs of Nawal Kishore Halwasiya, one of the partners of the assessee-firm, filed a suit against the receiver, namely, M/s. Talbot & Co., in the year 1950. This dragged on, and ultimately was settled out of court by a compromise dated 25th July, 1959. Under this compromise M/s. Talbot & Co. agreed to pay Rs. 64,680 to the assessee towards accumulated rent for the years 1950 to 1958, subject to a deduction of Rs. 13,329 towards income-tax and Rs. 3,234 as receiver's commission. They also agreed to pay Rs. 4,372, being interest on Govt, securities purchased by them on the assessee's behalf. In all, the assessee received Rs. 52,489. The assessee in its books deducted a sum of Rs. 8,492 from this amount as legal expenses incurred in the suit which was compromised. The balance of Rs. 43,997 was credited to the capital account of the partners.

13. The ITO, Calcutta, appears to have assessed M/s. Talbot” & Co. (receiver) in respect of this amount.

14. In appeal the assessment orders were set aside, and the matter was remitted for fresh assessment.

15. The ITO, Calcutta, appears to have written to the ITO, Lucknow, that the assessee should be assessed on this income. In due course the assessee filed revised returns for the assessment years 1951-52 to 1957-58 in relation to this income. The assessment orders accepted the revised returns and brought to tax the income returned for the years 1956-57 and 1957-58. For the remaining previous assessment years, no assessments could be made because the period of limitation had expired.

16. The ITO found that on 17th November, 1960, the assessee actually received an amount of Rs. 52,489 from M/s. Talbot & Co. in pursuance of the compromise of July, 1959. He brought this amount to tax for the assessment year now in question, namely, 1960-61, under the head “Other sources”. He held that in so far as this amount is concerned, the assessee had adopted cash system of accountancy, and, therefore, it was assessable in the year in which it was received.

17. On appeal, the AAC affirmed the finding.

18. The assessee went up to the Tribunal. The Tribunal noticed that the assessee had sold away its rights in the land as well as machineries installed on this plot in the year 1958, and, therefore, the source of this rental income itself had ceased to exist long prior to the accounting period relevant to the assessment year 1961-62.

19. In the next place, it was admitted that the assessee had all along “been following the mercantile system of accounting. The assessee was justified in not making any entry of receipt of rent on accrual basis till 1958, because due to the pendency of civil litigations it was not in a position to know whether it will receive any income at all from this property. Non-making of entries for the years 1951 to 1958 or so could not lead to the inference that the assessee had changed the system of accountancy from mercantile to cash in respect of this source of income.

20. The Tribunal further held that merely because the income escaped assessment because of the bar of limitation for the assessment years 1951-52 to 1955-56, there was no justification for the ITO to assess the entire amount as income for the year 1961-62 on cash basis. In this respect, the ITO acted in an inconsistent manner. On these findings, the inclusion of rental income was deleted.

21. We have no hesitation in accepting the finding as well as the inference drawn by the Tribunal from the basic facts. The normal method of accountancy of the assessee was mercantile. Applying it, the amount of Rs. 43,997 could, if at all, be held assessable only for the year relevant to the accounting year 1959, because the right to this amount accrued due in July, 1959, when the compromise took place. The same hence could not be assessed in the year 1961-62, for which the accounting period was the calendar year 1960.

22. In the next place, there was no material to sustain the view that the assessee had changed its system of accountancy in so far as the rental income from this property was concerned. The Tribunal was justified in taking the view that in view of the litigations which were pending between the parties, the assessee was not in a position to know whether it was at all likely to receive any income from this property during those years. The assessee was justified in not showing in its books of account any income accruing from this source in those years. Further, the action of the ITO in making assessments for 1956-57 and 1957-58, in respect of portions of this income could only be justified on the basis that the mercantile system of accountancy had been accepted for this very source of income on the basis of accrual in each of the years 1950 to 1958, for which the amount was received by the assessee under the compromise. Having passed an assessment order in respect of this very income on that basis, it was not open to the ITO to give a contrary finding for the present assessment year. The second quesion is also liable to be answered in favour of the assessee.

23. In the result, we answer both the questions in the affirmative, in favour of the assessee and against the department. The assessee will be entitled to costs, which are assessed at Rs. 200.

Addl. Commissioner Of Income-Tax v. Ganesh Das

Judicial Opinion Summary (Satish Chandra, C.J.)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee's Position

Revenue / ITO's Position

Table of Precedents Cited

Court's Reasoning and Analysis

Bad-debt question (Rs. 57,122)

Rental-income question (Rs. 43,997)

Holding and Implications

Addl. Commissioner Of Income-Tax v. Ganesh Das

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